Using US LLCs as a tax planning structure in Portugal has gained significant popularity, especially in benefiting from the non-habitual residents (NHR) tax regime. This extensive use can be traced back to a pivotal binding ruling requested by a taxpayer under process 2360/2016.
Case 2360/2016
The ruling clarified the Portuguese tax authorities’ view on US LLCs, noting that an LLC taxed as a partnership in the US is not necessarily treated as tax transparent in Portugal. The ruling emphasized that only professional societies or companies for the simple administration of assets could be considered tax transparent under Portuguese law. Consequently, income from a US LLC, unless fitting these categories, would be classified as “other income” and taxed at 28% in Portugal. This classification led many taxpayers without the NHR scheme to bear a substantial tax burden. However, had the NHR scheme applied, the tax liability in Portugal could have been zero due to the differing tax treatments between the US and Portugal.
Risks of Portuguese Taxation on LLC Income
Several risks could lead to Portuguese taxation of LLC income:
Interpretation Changing:
- The Portuguese tax authorities might eventually change their interpretation, although this seems less likely given the consistent finding that LLCs are not transparent entities in various jurisdictions, including the UK.
Different Treatment for Single-Person Disregarded Entities:
- Single-person LLCs, often pass-through entities without a separate tax return requirement, might face different treatment than partnerships. Non-member-managed single-person LLCs could be more likely deemed companies.
Residency in Portugal:
- If an LLC is managed or directed from Portugal, it would be considered a tax resident. The “place of effective management” is critical and often determines where key management decisions are made.
Permanent Establishment:
- Even without effective management in Portugal, a permanent physical presence or a director in Portugal could establish a permanent establishment, leading to taxation.
Portuguese-Sourced Income:
- Regardless of management location, income sourced in Portugal could still be taxed, although the tax authorities bear the burden of proof.
Defending Against Portuguese Taxation
To mitigate these risks, several strategies can be employed:
- Prefer C-corps over LLCs and LPs.
- Ensure overseas management is adequately documented.
- Avoid having a permanent office or a manager in Portugal with contract-binding authority.
Non-Habitual Residents (NHR) Tax Regime
The NHR regime offered competitive tax benefits for new residents, exempting foreign-sourced capital income, rents, and specific capital gains under certain conditions. The income must be taxable in the source country under a Double Taxation Convention (DTC) or the OECD Model Tax Convention to qualify.
Tax Treatment of LLCs and LPs Under NHR
Portuguese law does not explicitly address opaque vs. transparent entities like US LLCs or LPs. Generally, these are transparent under US law, with income flowing to partners. However, under Portuguese tax rulings:
- LLC income is deemed a dividend distribution, typically subject to 28% PIT – depending on very strict circumstances or
- The LLC, being tax transparent, is not considered a US resident for DTC purposes with Portugal; thus, the income falls under “other income,” allowing both countries to tax it.
Despite this, the NHR principles, focusing on the nature of income received by individuals, provide a pathway for potential tax exemptions under appropriate conditions.
Conclusion
US LLCs can be an attractive tax planning vehicle in Portugal, especially under the NHR regime, but they come with risks and specific tax treatments that need careful navigation. Structuring evolving US and Portuguese tax law experts in both countries is crucial to maximizing benefits and mitigating potential tax liabilities.
The founding of Madeira Corporate Services dates back to 1995. MCS started as a corporate service provider in the Madeira International Business Center and rapidly became a leading management company… Read more
